Investors look for next winners in SaaS, line up with millions of dollars

Enterprise software major Freshworks raised $100 million from Accel and Sequoia Capital India in Series-G funding in July, which could be the last private equity round before it goes for an initial public offering (IPO). 

Investors like companies in this space, as they are capital-efficient and enjoy customer loyalty. While Freshworks is way ahead of its peers, the next few years could see several companies breakout in this space. These include enterprise software companies like BrowserStack, RateGain, Manthan, Capillary Technologies, Zenoti, CRMNext — all of which are scaling well. 

‘‘I see many more companies crossing $50 million in revenue,’’ said Aneesh Reddy, founder & CEO, Capillary Technologies. 

Shailesh Lakhani, managing director, Sequoia Capital India, says Druva, BrowserStack and Capillary show a lot of promise. ‘‘Led by very strong founders, these companies have built world-class products and continued to push the envelope on product innovation. Their foresight and ability to go after global markets have separated them from those who have focused on selling in just India,'' he said.

All of them have raised Series-A/B funding, but only a few have raised Series-C. As they scale, many could be raising Series-C/D rounds in the next few years. Unlike the consumer business, enterprise software firms don’t need too much money to grow; some firms like RateGain, BroswerStack generate good cash and don’t need to raise money. Yet, there’s considerable investor interest. In February 2018, Warburg Pincus led $20 million Series-C funding in Capillary Technologies and Temasek co-led $125 million in Pine Labs in June 2018 after leading a $60 million funding in Manthan in 2015. 

Large investors like Premji Invest, TA Associates and General Atlantic as well as venture capitalists like Lightspeed India are closely looking at SaaS (software-as-a-service) companies. SaaS is one of the ways of selling enterprise products, where companies charge customers a monthly subscription rate based on annual contracts for software hosted on the cloud.

‘‘For investors, the appeal lies in large markets these players are going after, the increasingly larger businesses they are winning on the back of their tech and product chops (ability to build good products), along with their solid SaaS metrics,'' said Lakhani of Sequoia.

 

The investor interest is much higher than earlier, say industry insiders. 

The two sectors together accounted for nearly 59 per cent of the Corporate India’s incremental net sales growth during the Q1 and nearly all of the incremental profit growth. 

The combined net profit of companies, excluding financials and energy, was up 24.9 per cent YoY in the quarter, the best in at least three years led by companies from metals and mining, consumer goods, capital goods, pharmaceuticals, and information technology services sectors. The sample’s combined net sales was up 12.9 per cent YoY, growing at the fastest pace in at least 12 quarters.

The quarter also saw growth recovery in domestic market-focused companies but the buoyancy in their earnings was less than that in the commodity companies. The combined net profit of companies (ex-energy, financials, IT, pharma and metal and mining) was up 17.3 per cent YoY, growing at the fastest pace in last seven quarters, while their combined net sales was up 9.5 per cent YoY — the best in the past eight quarters.

Consumer companies have been the toast of Dalal Street in the current earnings season and most of the companies seem to have recovered lost ground after demonetisation and the GST roll-out. But those serving discretionary consumer spending (automobiles and consumer durables) grew faster than staples - personal care, food, and tobacco companies.  

A surge in big-ticket consumer spending was aided by a surge in retail lending, especially non-banking lenders such as Housing Development Finance Corporation, Bajaj Finance, Capital First, M&M Financial, and Bharat Financial among others. 

The combined net profit of non-banking finance companies was up 29 per cent YoY during the quarter, while their net interest income was up 26.6 per cent, outpacing the growth in banking sector by a big margin.

Rising commodity prices have, however, begun to eat into the margins of domestic manufacturers. Domestic companies’ raw material and energy costs as a per cent of net sales was at five quarter high in the June 2018 quarter. Its impact was most telling in the auto sector where companies failed to impress the Street despite strong double digit growth in revenues and profits. 

“Investors are now worried about a steady decline in industry's margins, which could nullify the gains from higher volumes this year,” said G Chokkalingam, founder and MD, Equinomics Research & Advisory Services. 

But overall, analysts expect corporate earnings in FY19 to be better than last fiscal barring any unexpected development in India’s external economic environment.

Accel recently led a $50 million Series-A round in SaaS major BrowserStack while TA Associates invested in Rate Gain, which makes software for the hospitality and travel companies. 

‘‘Suddenly, you have companies which have crossed $25 million. For a large investor, unless a company is of a size, it doesn’t make sense,’’ said an investor, requesting not to be named. Typically, companies in enterprise software are valued at 10 times their revenues. So a firm with $25 million revenue is valued at $250 million.

Large investors typically write cheques of $50 million and founders don’t want to dilute more than a 10-20 per cent stake. Hence, companies need to be of $25 million or more to take a cheque of $50 million. Investors want the companies to get to $20-$25 million is revenues before they can invest. 

Second, lot many enterprises in Asia and Southeast Asia are buying cloud software compared to on-premise software they were using earlier. Even companies like SAP and Oracle have acquired SaaS companies. For SMB (small & medium businesses)-focused players like Freshworks and others, customers are buying online.

Third, there’s a lot more sharing of learnings among SaaS companies, which is helping them scale faster. For instance, founders of six firms meet once every quarter and share their learnings. ‘‘There’s a lot more combined learning, which is shared openly. When we started, we had to invent the wheel, do things twice before we got it right,’’ said Reddy. 

The excitement in SaaS is not just limited to the big companies, which have been around for some time, but extends to niche start-ups. 

Between 2015 and 2017, when there was consolidation in many consumer internet businesses, VC firm Lightspeed India backed around 10 b2b companies and only a couple b2c firms. These include b2b marketplaces like Udaan, Indian Energy Exchange, b2b services firms like Freighttiger, Priority Vendor, Innovacer, Darwin Box. It has invested in three other SaaS firms but not announced them. 

What makes them attractive for investors like Lightspeed? ‘‘These are high impact, high-value companies targeting large markets,’’ said Dev Khare, partner at Lightspeed India. For instance, CRM is a $30-billion market globally and HR software is a $20-30 billion market, and there is an opportunity to create companies with revenues of $100-400 million.

‘‘Freshworks is an exemplary company that is firing on all cylinders. They have certainly created a path many others will follow. There are a number of promising young companies out there which are charting their own paths — either by selling to enterprises, going after more regional markets, or going after verticals. Many of them are expected to have extremely positive outcomes," said Lakhani.